Real resources are always a true constraint for any economy. This has become an increasingly important point over the last 10 years as commodity prices have surged. But the debate over the cause of this surge and the lack and real resources is still very much up in the air. Some say it is due to an insatiable demand from China. Some blame the decline of the dollar due to irresponsible government action. Others say Wall Street is cornering the commodities markets and turning it into another profit making casino. The truth, in all likelihood, lies somewhere inbetween.
One of the more important themes I’ve discussed over the years here has been the financialization of our economy. Financialization has seeped into many facets of our economy in order to help the big banks maximize profits. This has led to massive deregulation, increasing reliance on the FIRE industry, a concentration of power in this industry and an economy that is increasingly volatile and dependent on this industry which produces little, but takes much. This financialization has been nowhere more apparent than it has been in the commodities markets.
A few weeks ago I wrote a piece about the continual imbalance in the commodities markets and a veteran of the energy market happened to be reading. Dan Dicker reached out through the comments section and offered to send me a free copy of his book, Oil’s Endless Bid (see here to buy a copy). I had heard of Dan’s book and had been meaning to read it for some time. Now, I get a lot of free books from financial people. A LOT. They all want me to promote their books on the site. 95% of the books never get mentioned on the site. As you’ve noticed, I don’t just crank out content for the sake of cranking out content and the “payment” of a free 300 page book is not really incentive enough for me to write about a book. So, a lot of books end up in my fireplace (I’m an energy conservationist obviously). This one is different because I think Dan is conquering an incredibly important subject and he does so from the position of an informed insider.
His perspective is very much in-line with the positions of Michael Masters who has been one of the more vocal proponents of this financialziation of the commodities markets. Dan Dicker is a 20+ year veteran of the oil markets and a long-time seat holder at the NYMEX. Dan’s book is a frighteningly eye opening perspective from someone who has been in the trenches and has witnessed the massive changes in real-time. Dan highlights the massive changes that occurred over the years as the industry has morphed from one that was dominated by big oil into an industry that is dominated by big banks (from the book):
“In the mid-1990’s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies. The list of NYMEX seat owners again shows just how deep the change was. Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products. But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.
- BNP Paribas: 9 seats
- AIG: 6
- Merrill Lynch: 5
- Bank of America: 4
- Barclays: 4
- Citigroup: 4
- Deutsche Bank: 4
- JP Morgan: 4
- Morgan Stanley: 4
- UBS: 4
- Bear Stearns: 3
- Goldman Sachs: 3
- Lehman Brothers: 2
That’s a total of 56 seats owned by investment banks! (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.)
Of course, the most important purpose for some of these firms to own seats was to execute orders for clients, some retail, but many commercial clients who were being sold on the importance of risk management of energy costs. And during the years from the mid-1990’s though 2005, this made for a legitimate increase in the volume of crude. But commercial growth of risk management programs was a happy appetizer for the quick rise of the investment banks in the trade of oil. Oil companies that tried to maintain a presence and dominance in trading began to be overshadowed by the volume and influence of trading from these banks and their clients.”
These firms aren’t dominating the trading pits at these exchanges because they want to buy and sell commodities for real economic purposes. They are dominating the exchanges because they know there is big money in financializing the asset class of commodities. And they’re succeeding. They’ve sold the asset class as an investment and the investing public has eaten it up hook, line and sinker. Dan goes into much more detail about this destructive trend and its impact on the economy and ultimately concludes that massive change is needed. We need to get control of our economy again and wrangle it back from these big banks who are looking out for the interest of their shareholders and not the US economy. Dan Dicker’s book is one of the most important ones I have read in a long time. It should be required reading for the US Congress.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.